Good day, ladies and gentlemen, and welcome to the fourth quarter 2014 Badger Meter earnings conference call. My name is Lisa, and I'll be your operator for today. At this time, all participants are in listen only mode. Later, we will conduct a question and answer session. If at any time you require operator assistance, please press star followed by zero and we will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Rick Johnson, Senior Vice President of Finance and Chief Financial Officer. Please proceed, sir.
Thank you very much, Lisa. Good morning, everyone, welcome to Badger Meter's fourth quarter and year-end conference call. I want to thank all of you for joining us. As usual, I will begin by stating that we will make a number of forward-looking statements on our call today. Certain statements contained in this presentation, as well as other information provided from time to time by the company or its employees, may contain forward-looking statements that involve risk and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see yesterday's earnings release for a list of words or expressions that identify such statements and the associated risk factors. Let me reiterate some of our guidelines. For competitive reasons, we do not comment on specific individual product line profitability, other than in general terms, nor do we disclose components of cost of sales.
We continue our practice of not providing specific guidance on future earnings. We believe specific guidance does not serve the long-term interests of our shareholders. On to the fourth quarter results. Yesterday, after the market closed, we released our fourth quarter and year-end 2014 results. We are pleased to report a fourth quarter record sales amount of $89.3 million. This represents an increase of $8.3 million or 10.3% over the fourth quarter sales in 2013. This increase was due to higher sales of both municipal water and flow instrumentation products. Specialty products were relatively flat between years. Let me review each of these sales categories. Municipal water sales increased $7.5 million or 13% to $65.2 million from $57.9 million in the fourth quarter of 2013. These sales represented 72.9% of total sales for the quarter.
Included in this amount is approximately $6.1 million of incremental sales from National Meter. You will recall that we purchased National Meter effective October 1st of 2014. They were and continue to be a major distributor of the company's municipal water products. The remainder of the increase was driven by higher unit volumes of meters and radio technology. While we did see increases in residential products, we saw a decrease in commercial sales from the fourth quarter of 2013 to the fourth quarter of 2014. The fourth quarter of 2013 was unusually strong for commercial sales compared to the fourth quarter of 2012. We attribute this just to the lumpiness of the business as opposed to any fundamental changes in the market. Flow instrumentation sales increased $900,000 or 4% as we saw volume increases over most product lines.
As I noted, specialty products were relatively flat as the net impact of higher sales of Wyco concrete products was offset by lower sales of radios to the natural gas meter market. The gross margin as a percent of sales for the fourth quarter was 34.6% compared to 35.8% last year. Without getting too technical, some of this is an impact of the National Meter accounting. National Meter's inventory balances were much the same at the beginning of the quarter as they were at the end of the quarter. The difference is the inventory they had on hand at the beginning of the fourth quarter was sold to them by us prior to the acquisition, whereas the inventory they had on hand at the end of the year was sold by us after we owned them.
As such, on December 31st, we eliminated the profit that was still in that inventory at year-end. In the future, inventory balances will be adjusted for changes in the amount of profit in inventory, but these adjustments are not expected to be significant. This initial adjustment will become a moot issue, but it did have a negative impact on the margin this past quarter. Higher than expected warranty claims and healthcare costs also had a negative impact on the fourth quarter gross margin. On the positive side, we experienced favorable foreign exchange rates and lower cost of raw materials, particularly brass castings during the quarter. Selling, engineering and administration expenses, our so-called SEA, increased $4.1 million over the fourth quarter of 2013. $2.5 million of this increase is related to National Meter.
The remainder of the increase was due to higher employee incentive costs and higher health insurance costs, both of which were offset somewhat by lower product development costs. The effective tax rate for the fourth quarter was 24% compared to 36.8% last year in the fourth quarter. Part of the reason for the difference in the quarter is the math needed to get to the actual annual rate. In addition, we weren't able to recognize the federal R&D tax credit until it was renewed by Congress in the fourth quarter. The annual effective tax rate for 2014 is 33.9%, which compares to 35.2% last year. The lower annual rate this year is due primarily to two factors. We were paying lower state taxes given the particular mix of states we're selling in, and we had a higher mix of foreign income this year versus last year.
Foreign tax rates are generally lower than the U.S. tax rate. While we had higher sales, the lower gross margin percentage and the higher SEA cost resulted in lower operating earnings. Even with a favorable tax rate for the quarter, we are still slightly below 2013's fourth quarter earnings at $6 million compared to $6.4 million last year. On a diluted earnings per share basis, it was $0.42 this year versus $0.44 last year. Let me also comment on the year as a whole. Sales increased $30.7 million or 9.2% to $364.8 million from $334.1 million last year. As I noted, $6.1 million of this is for National Meter. The increase was clearly driven by higher sales of municipal water products due to higher volumes of products sold, and flow instrumentation also showed an increase year-over-year. Sales were a record for the year.
The gross margin percentage for the year as a whole increased to 36% compared to 35% in 2013. The higher volumes of products sold helped with capacity costs. We had lower obsolescence expenses, lower raw material costs, and favorable exchange rates. Offsetting these factors for the year were the product mix, since we skewed slightly more to municipal water, which has lower margins than the flow instrumentation products. Margins were also impacted by higher warranty costs and the one-time accounting item for National Meter. Overall, selling, engineering, and administration expenses were substantially higher than last year with a 9.3% increase. You may recall in the first quarter, we had a charge of $1.7 million for an acquisition that ultimately wasn't pursued. We also had expenses associated with National Meter operations in the fourth quarter that we did not have last year.
In general, we had higher employee incentives in 2014 due to the better financial results, and we had lower product development costs. Product development expenses returned to more historic levels after several years of higher costs to get new products out the door. Earnings for the year were $29.7 million, or $2.06 per diluted share, compared to $24.6 million or $1.70 per share in 2013. Our balance sheet remains solid. Even after the acquisition of National Meter in 2014, our debt as a percentage of total capitalization was 26.2% at year-end, virtually where it was at the end of 2013. Finally, cash generated from operations increased from $34.8 million in 2013 to $35.7 million in 2014.
Due to a planned movement of some of our product lines in the first quarter of 2015 within our Nogales plant, we built additional safety stocks of certain products that resulted in higher inventory balances at year-end. Without this project, cash generated from operations would've been several million dollars higher. With that bit of background, I will now turn the call over to Rich Meeusen, Badger Meter's Chairman, President, and CEO, who will have some additional comments. Rich?
Thank you, Rick, and thank all of you for joining us today. As Rick pointed out, our fourth quarter results had some unusual impacts, including the one-time National Meter inventory impact and a lower income tax rate. These types of impacts on a single quarter can reflect the lumpiness of our business when viewed in the short term. Looking at the bigger picture, the full year's results clearly reflect our strongest year ever, and we're very pleased with that performance. We also had some major accomplishments in 2014 that will position us well going forward. First, we completed the acquisition of National Meter and Automation, our largest distributor, with headquarters in Denver and operations in several Western states. This acquisition brings us closer to our customers, allows us to work more closely with our field salespeople, and can serve as a platform for future distribution operations.
The integration has gone very well, and National Meter's fourth quarter operating results were on plan. We're seeing continued acceptance and growth in our newer products. Sales of the E-Series electronic water meters more than doubled from 2013 to 2014. In early 2013, we introduced the ORION SE radio, which provides simultaneous drive-by and fixed-network water meter reading capability. We also saw sales of that product more than double from 2013 to 2014. Last year, we introduced our newest product, the BEACON Advanced Metering Analytics system, with its cellular-based radio. We have seen strong sales of our starter kits in 2014, plus several utilities have made a commitment to adopt the system throughout their service territory. These three new products, the E-Series meter, the ORION SE radio, and the BEACON AMA system, are all driving sales growth and strong margins for Badger Meter.
Recently, we've been getting many questions from our investors about the impact of copper prices on our business. This became a hot topic back in 2011 when copper exceeded $4 per pound, and it's again becoming a topic of interest as copper has recently dropped below $3 a pound. These sudden changes in copper prices can have a significant impact on our margins. As most of you know, the majority of our water meter sales, both residential and commercial, consist of brass meters. In fact, we purchased over 7 million pounds of brass ingot last year. Our brass ingot is comprised of 89% copper, although most of the ingot comes from scrap brass. Nonetheless, our ingot prices tend to track fairly closely with copper prices. The recent drop in copper prices, if sustained, could have a favorable impact on our 2015 results.
The average cost of copper last year was approximately $3.10 per pound. Copper this morning is around $2.55 per pound. We are not yet seeing any significant pricing pressures in the market related to this decrease, although continued low copper prices could create some competitive pressures. I'll also remind you that due to the supply chain, we have a delay of about one quarter between copper price changes and the impact hitting our margins. As such, the margin in the first quarter of 2015 will reflect the price of copper from the fourth quarter of 2014, which was still over $3 a pound. Looking forward, with this potential copper price tailwind, the strength of our new products, and our strong competitive position in the market, we believe that we're in a solid position to drive continued growth in both sales and earnings over the long term.
With that, we'll take your questions.
Ladies and gentlemen, if you have a question, please press star followed by one on your phone. If your question has been answered or you would like to withdraw your question, press star followed by two. Please press star one to begin. Your first question comes from the line of Richard Eastman with Robert W. Baird. Please proceed.
All right. Good morning.
Morning.
Hi, Rick.
Hey, just a couple things maybe related to National Meter. The $6.1 million in sales that you noted here in the fourth quarter seems awfully high. Is that seasonal? Are we thinking just seasonality aside, $6 million a quarter is the run rate?
Well, part of that, when we said we bought National Meter, we said it will add about $15 million of incremental revenue.
Yep.
You're seeing some of that in the $6 million. You're also seeing basically what I call the distributor margin only for the inventory they had at the beginning of the period. In other words, when we sell it to them, they always sold it for a little bit more, we're seeing some of that incremental sales in the number.
Okay. Now, again, does that annualize out in the quarter? Put it this way, when modeling NM for 2015, are we better off to use a $15 million revenue number incremental for the full year?
Rick, this is Rich. First off, National Meter does have one large project that's going out west that is boosting us up, and that project will carry us into 2015. I think you're probably safe estimating a little bit higher. I wouldn't take the $6 million and multiply it by four, but I think you'd be safe going north of $15.
Okay. Now, the gross margin kind of gets wiped out with the purchase accounting here.
Yes.
My impression is that this is, on a normalized basis, maybe 55%-type gross margin. Can you just get us in a range here?
Well, when you're talking about adding Badger's normal gross margin on what we were selling to National Meter, plus National Meter's gross margin on what they sell.
Yep
It's obviously higher than Badger's average in the mid-thirties. I would say, I'm not sure I would go as high as 55, but 50 is probably a pretty close number.
Okay. All right. Just one question on the SG&A. Rick, you just kind of mentioned the SEA expenses. I guess you attributed about $2.5 million to NM. Is there any legal professional fees in there, or is that kind of an SG&A run rate for them as well?
That is their run rate.
Okay. The fact that Badger's kind of core SEA expenses were a bit high, is some of this like, say, the healthcare, is any of that kind of truing up your year-end expenses or?
Actually, what happened is, for the year, our healthcare was probably only about 6% higher. Unfortunately, for the first three quarters, we were really running low.
Okay.
We're self-insured. In the fourth quarter, we got hit pretty hard. It's hard for us to, is it because it's people using their flex amounts at year-end or whatever? We're doing some analysis of that to try and get a better estimate. It was kind of shocking. On the other hand, being self-insured, it only takes two or three significant medical expenses to really influence that amount in a particular quarter.
Okay. Just maybe last question, I'll get back in the queue then. The seasonal tone to the business, Rick, we had obviously the storms in the Northeast. How does the seasonal tone to the resi water municipal business feel through January? Obviously, your first quarter sequentially can be plus double digits or minus double digits sequentially. Can you just give us any sense of how the tone is through the first month here seasonally, and if the Northeast storms kind of got us off to a slow start or were a non-factor?
This is Rich. You're absolutely right, Rick. The first quarter weather can have such an impact on us because Badger Meter does have a large market share in the upper Midwest and the Northeast. We've seen in the past that the seasonality, the weather can really impact us. I would say you're right. Some of the storms we've seen during the month of January have had a slowdown for us. The quarter is probably off to a little slower start than what we would normally see with a normal weather pattern. That isn't to say it won't make up. Sometimes we have a really strong March. I think it all comes down to groundhog predictions or something. If the winter ends faster-
Okay
better quarter.
All right.
Rick, if you remember in the first quarter of 2014, because we had the same issue and we had similar weather. What happened is we had a greater mix of sales in the western states, which by the way, doesn't get played up a lot on TV, but really had very mild weather in the first quarter of last year. It had that positive impact on us. It also depends where the customers are at that point in time. I would agree with Rich. We are seeing a little bit of a slowdown, especially in the Northeast.
Yeah. Okay. Fair enough. All right. Thank you very much.
Your next question comes from the line of Ryan Connors with Boenning. Please proceed.
Good morning. Thanks for taking my call.
Good morning. It's Boenning. We know it's Boenning.
Boenning. Right. Boenning.
That's right.
Wondered if you could just talk a little bit about the competitive environment. Obviously, we had a big industry show this week. You all introduced BEACON last year at DistribuTECH. I'm wondering if you've heard anything from your people there about competitive offerings and people trying to catch up to some of the things you've done, and whether there's anything that seems meaningful. Also just get an update on anything that you've all rolled out this week there, if anything.
Ryan, this is Rich again. Let me take the last part first. Our rollout has continued to be our flagship product now, which is the BEACON AMA system. We brought out EyeOnWater, which is a downloadable app, which allows the homeowner to monitor their own water usage. A lot of the utilities want to provide that data to the homeowner, especially utilities out West, where they're trying to encourage conservation. That was our big push, and we've certainly got a lot of customers who are interested in that, and they're looking at the entire BEACON system, in some cases, because they want their customers to have that app. That's been a real positive for us.
Other things we saw at the show is that, I think this is significant, right now, a couple of our competitors have been moving away from brass meters in the residential market and more over to the polymer meters. At this point, really only two companies, Badger and Neptune, are primarily leading with brass meters. Meanwhile, Mueller, Sensus, some of the other smaller players are really pushing the polymer meters simply because it's lower price, and they can compete more aggressively on price. I think that's an interesting fact when you consider what's been happening with brass prices. You might assume that lower brass prices benefit all companies equally. That might not be true in this scenario. The other thing that's happening is we have seen some other companies coming in with new technology.
There are a couple companies from Europe that were actually displaying at the show for the first time, these are companies introducing electronic metering, trying to get a foothold in the U.S. I think they're going to have a lot of challenges doing that, just as we would have challenges doing missionary work in Europe. We did see them there. I'll also say that some of our competitors started talking about cellular products and started talking about solid-state metering, but we didn't always see products. That's really what was coming out of the show.
Okay. Interesting. Thanks for that update. On BEACON AMA, you talk about these, you've got some commitments now to do some fairly sizable rollouts there. Any regional focus to that? What is it that those systems like about the product that's caused them to go forward?
Yeah, I would say I'm a little surprised that we are not seeing a regional impact. The interest in BEACON has been across the U.S. now for different reasons. Out West, there might be a little more focus on the conservation tools that BEACON implies. Out East, there's a little more focus on the fact that they don't need infrastructure, that they can put in these cellular units without devices on towers that can be knocked down by windstorms and all of the other issues. For various reasons, the utilities across the U.S. are looking at BEACON pretty much evenly. We're not seeing any area that it's increasing more than anywhere else.
Okay. Is there something or adopting it have in common in terms of what the real components of the system are that they like? I know there's a number of different.
I would say the lack of infrastructure is probably the biggest issue. The second biggest issue is the software and the availability of the data.
Okay, great. Well, that's all very helpful. Thanks for your time.
Good. Okay, see you.
Your next question comes from the line of Kevin Bennett with Sterne Agee. Please proceed.
Hey, good morning, everybody.
Morning, Kevin.
Rick, first question for you, a bit of a clarification. Can you give the numbers of the flow instrumentation and specialty product sales, the actual dollar amount?
Did I not give them? Standby.
If I missed that, I apologize.
No, actually, I didn't give the numbers. We'll get back to you on that.
Okay, that's fine. One other question for you, are we finished with the initial accounting adjustments on National Meter? I guess the question is really, the margins there, are we back to a normal level, or is it going to gradually improve as we get through the year?
This is Rich, while Rick is looking, I'll exercise my old CPA certificate and tell you that we should be done with it, assuming inventories remain fairly stable. The problem was that, I'm going to try to say this without letting my disdain for modern purchase accounting rules creep into my voice. The problem was that on October 1st, we were required to write all of the inventory up to market, on December 31st, we were required to write all of the inventory down to cost, eliminating intercompany profit. In the future, it will always be written down to cost, therefore, barring any huge swings in inventory levels, there shouldn't be any impact.
Got you. That makes sense.
Rick has your answer. Rick has your answer.
Perfect.
Flow instrumentation sales in the fourth quarter were $22.3 million this year, $21.4 million last year, and specialty sales were about $1.9 million in both years.
Perfect. Thank you. Rich, one more clarification. If I think within municipal water, do you give a breakdown of how much is residential versus commercial?
Generally, no. We do talk about residential being up versus commercial, and it's different because residential sales are generally driven more by technology, whereas commercial sales are really driven by unit sales of the meters themselves, because there's a lot more metal there. The analogy is, on a plain residential meter, we might sell it for $40. If it's got a radio, we might sell it for $150. Okay? You're talking radio. If you're selling a commercial meter for $2,000 versus $2,100 with the radio, it's not that big a deal. That's why we talk about the distinction.
It's roughly 80/20.
Roughly.
Our revenues come up from 80/20. 80% is residential, 20% commercial.
Got you.
Another interesting fact about that is that the brass we use, though, is about two-thirds residential and one-third commercial, because obviously the commercial meters are the larger meters.
That makes sense.
If that helps you understand.
Yeah, definitely. That makes perfect sense. Then lastly, Rich, we've heard from some other companies that have had positive things to say about the overall municipal market, and just was wondering if you would share your thoughts on the broad market.
The customers I've spoken to, and a few weeks ago, we had our national sales meeting, so I was down there. We include all of our distributors. Basically, it's all the boots on the ground that we have. In talking to them, there was a very positive attitude. A lot of people were very upbeat. Our municipal customers, even if their money is segregated from the rest of the city, are very sensitive to the overall economy in their city and how the city is doing. I would say there was a lot of optimism.
Yeah. Finally, we're seeing some stability.
Yes.
When you talk about consumer confidence and what you're just reading about in the papers, municipalities are feeling that same thing, and they see that stability.
Yep. Thank you, guys. I appreciate it.
Okay.
Yeah.
Your next question comes from the line of Hassan Doza with Water Asset. Please proceed.
Good morning, guys.
Morning, Hassan.
A couple of questions. Just wanted to make sure I understood the SG&A run rate for National Meter. You mentioned $two and a half million. Is that run rate to use per quarter?
Yeah, that's fair.
About $10 million a year?
Yep.
Okay.
Per quarter.
I was trying to understand the economics, because let's just say you mentioned the revenue is going to be north of $15 million. Let's just pick $20 million, and if the gross margin is 50%, that's $10 million of annual gross margin, and then you have $10 million of SG&A. This business is.
Hassan, let me stop you.
Yeah.
What you are forgetting is, we have said incremental revenue. We sell them product, okay? There is still the manufacturer's profit. When we made that disclosure of 15, that is the incremental sales over and above the sales of our products. We never really did disclose what their sales were of our products. Okay?
Would not this-
We do not have them to do the model.
Right, but would not this SG&A is also incremental SG&A? I am trying to understand the-
Well, it's incremental to the company, but it's their SG&A.
It's their SG&A, yeah. Most of their cost-
Right. I'm trying to understand-
Most of their cost is SG&A because they're basically taking a manufactured product already and reselling it.
I understand, I was just trying to understand from this incremental, say, $15 million, $20 million of revenues, what is the net income or EPS to Badger Meter? That is why when I was going through the gross margin, the incremental gross margin on this incremental revenue and applying the incremental SG&A, I was coming to basically an incremental zero EBITDA contribution to Badger Meter.
What you're missing is their sales of our products. Basically, what we disclosed before is we paid about $20 million for National Meter. We paid about 7x EBITDA. Our projected EBITDA for 2015 is about $3 million from them.
Okay, I got it. Okay. $3 million of increment. Okay, I got you. Okay.
Incremental EBITDA.
Okay, fair enough. The second question I have is, in terms of your industrial meters and flow products, especially to the oil, gas, and petrochem industries, what kind of impact are you seeing, given the decline in oil prices, the fundamental demand for industrial meters from that specific industry?
We have been seeing, during 2014, an uptick in our sales of meters into the oil and gas fields, particularly in the fracking area. Okay? We are not seeing much change right now, but if I had to guess, I would say if oil prices stay low in 2015 and some of those fracking operations shut down, we could see some lower sales in those areas.
In very high level, roughly, what % of your total revenue would you say is exposed to the oil, gas, petrochem industries, fracking, et cetera?
We don't disclose that.
Not that much
It isn't more than a few %.
Okay. The last question I have is on your copper pricing. Rich, I think you mentioned about the lower copper price may lead to more competitive pressures. What I kind of wanted to understand is fundamentally, what is sort of the historically, when you have a copper price move to the downward like you have now, what is sort of the sharing to customers? Do customers want a lower price? What is sort of the pass-through we should think about that the savings have to be shared to customers because of the lower copper price? How do you think about the sharing of the savings?
I would say that the pressures generally come from our competitors, not from the customers, okay? Customers are doing comparison pricing. The reality is this: If any particular significant customer would come and say, "I'd like to lock in at these lower prices," we would ask for firm delivery dates, and municipalities generally cannot do that past one year out. Therefore, it's very difficult for them to lock in pricing unless they're also willing to lock in delivery dates. From our standpoint, our argument is that we still think it's a volatile raw material. There are studies out there. Help me. JPMorgan recently said they expect copper to be back up around $293 by the end of the year. $293 by the end of the year. We're still seeing that kind of thing out there.
We're not getting the comments so much from the customer. It'll be interesting to see what competitors doing, as Rich said, okay? Between us and Neptune, we're the ones that are primarily using brass.
Right. Aside from copper, what is the fundamental industry pricing you see today versus a year ago? How would you kind of think about it?
I would say pricing today is pretty stable compared to a year ago. Correct.
Okay. Thanks, guys. Appreciate it.
Okay.
Your next question comes from the line of Brian Rafn with Morgan Dempsey Capital Management. Please proceed.
Good morning, guys.
Hi, Brian. Morning, Brian.
Hey. Rich, talk a little bit about, if you look at the strategy, the vertical integration, buying National Meter as a wholesale distributor, beyond just the absorption of the gross margin of, say, 15% ballpark, what other benefits does that give you? Is there direct interaction with customers? Is there some SG&A leverage? In totality, what does that benefit you guys, bringing them under your umbrella?
Sure. There's a little bit of SG&A leverage, but not much, okay? I had an old college professor who used to teach us that an axiom, anything that brings me closer to my customer is a good thing, and anything that takes me further from my customer is a bad thing. Although I don't always follow the advice of college professors, that one seemed pretty good. It does bring us closer to our customer and gets us faster information on what the customer's preferences are. There's another aspect here, too, and that is that as our sales become a more complex technology sale, especially things like cellular and software that needs to be demonstrated, this is a sale that really requires somebody to go in and sit down one-on-one and sell this product to a customer.
Expanding our boots on the ground, expanding our reach into the distributor network allows us to better control that function, and I think can only improve the sales experience we have.
Okay. As you look at, I'm not gonna call it encroachment, as you look at that vertical integration, are these transactions driven by mutual harmony? Is it wholesalers that are family businesses, and there's no more siblings? Is it financial? What kind of drives the cadence of that?
Thus far, okay, I would say this is mutual harmony. That's one. Because it's one. It's the case of National Meter, they were interested in selling, we were interested in buying. Having said that, we have other distributors where the ownership is maybe coming closer to retirement and is thinking about what their exit strategy is, we're certainly out there talking to them, and we're interested in doing something on a mutually beneficial basis. I'll also say, we do have some small distributors who may not be performing as well. In those cases, we may have to have a harder conversation where we simply look at absorbing territory or dealing with them in a different light. That could happen. In saying that differently, we've always taken the bottom distributors out. There's probably one or two that we turn over every year. Yes.
That is not gonna stop. Badger Meter really has, we have about, I think 30 distributors. Yeah. About a third of them are very large, very good. We really work very well with them. Then there's probably a bottom third where there's some struggling, and we either have to improve them or find a way to change.
Okay. Yeah. I appreciate the call. You talked a little bit about BEACON Software, AMA, and you've got some kind of first-mover adopters. If my count is correct, you always talked about 54,000 water companies. What first tranche? Are we talking about a couple? Are we talking dozens? How does that adoption cycle kind of move through that industry?
Okay, Brian, your phone is cutting out on us there, we were missing about every third word, I think I got the gist of the question here. You're asking me about the early adopters of our BEACON system and whether it represents the very large utilities, the very small utilities, or the medium-sized utilities. Again, I have to say, it's been pretty much across the board. We've had people adopting systems across the board.
Okay. Then, can you hear me now?
No, you're still cutting out pretty bad. You might want to hang up and redial in, Brian.
Thank you.
Okay, Lisa, we can take another call, I think.
Certainly. Your next question comes from the line of Glenn Wortman with Sidoti. Please proceed.
Yeah, good morning, guys.
Morning, Glenn.
With respect to the gross margin, can you just please remind us, the stronger dollar, that's still a benefit to you, right?
The stronger dollar, well, let me give you some color on that, okay? Badger Meter has basically two major impacts. One of them is the fact that we do buy some of our ORION radio boards from Europe, the fact that we have an operation in Europe that sells primarily industrial flow meters. In the past, the purchase of the radio boards, the euros spent on that, has exceeded the euros generated by our European operations. Therefore, a stronger dollar would benefit Badger Meter. Having said that, the newest ORION products, ORION SE and the ORION Cellular, those boards are no longer bought from Europe. Those are being bought from other places in dollars. Therefore, that advantage we had, or that imbalance, has shrunk, and we're getting pretty close to breakeven.
Right now, we still got a little bit of a benefit from the stronger dollar. We're getting to the point where our euros spent pretty much equal our euros generated. In 2015, that's kind of what we're anticipating. Meanwhile, the other side is we do have an operation down in Mexico. The stronger dollar against the peso does benefit us there.
Okay. Thanks for that. Just focusing on the competitive landscape. In 2014, you had some additional Elster business. You also have a lot of success with your new product introductions. Do you have any sense of how you performed relative to the industry last year?
It's getting harder to get really good numbers on the industry. The reason is some of the sources we have are not as accurate as they used to be. We do believe we gained some market share last year. That's purely anecdotally. I really don't have good surveys that give me that answer.
Okay. All right. Thanks for taking my questions.
Sure.
Your next question comes from the line of Chip Moore with Canaccord. Please proceed.
Thanks. Good morning, guys. On margins in the quarter, I was hoping maybe you could tease out a little bit more impact of that inventory step-up charge. Then also, I think you called out some higher warranty claims. Is that just typical of new products type of scenario, and what are some of the impacts there?
Sure. This is Rich. Obviously, you can do the math on the impact of the National Meter inventory, right away, take that $1.2 million, if you deduct that out of cost of sales, it brings the margin up. We had the higher healthcare costs, a hunk of that, or probably the majority of that, falls into cost of sales. That had an impact. We did have some higher warranty claims, as Rick mentioned, but the major impact there was on the flow instrumentation side. We did have some meters that were being used in an application that turned out not to be the right meter for those applications. After working with the customers trying to make them work, we finally decided to pull them out of the field, refund the customers money. That was about a $360,000 hit that we took on that.
Those are really the impacts that had a major effect on the fourth quarter margin.
Got it. That's helpful. Have you looked at it, if you normalize for those factors, what it shakes out at roughly?
I think you can add anywhere from 150 basis points-200 basis points if you take those out.
Yep. Okay. Then on National Meter, just one question here. In terms of working capital, should we be thinking about anything different now that you have that distribution business in-house?
No, it'll help us generate a little bit more cash per year, but in terms of working, they do not anticipate growing their inventory. I don't see a need that we'll have to. That is working capital. I always think on a cash basis. They'll generate more cash for us, and that'll help us eventually pay down debt.
Yep. Okay, great. I guess we'll all wait to see what Punxsutawney Phil says here in Q1.
Yeah.
Thanks.
I think you're right.
Well, he's already made it, isn't he?
Well, he's made his prediction, but I think the groundhogs are becoming less reliable. One of the ones in Wisconsin bit off the mayor's ear. I don't have a lot of faith in them.
It's still looking pretty cold here. Thanks.
Yep.
As a reminder, ladies and gentlemen, to present your question, please press star one. Your next question is a follow-up from the line of Richard Eastman with Robert W. Baird. Please proceed, sir.
Yes, I'm back. Thanks. Hey, Rich, maybe you could pull the groundhog trick at one of these conferences, one of these institutional conferences. Bring a groundhog with you.
That would at least liven things up a bit.
Please don't tell him that, Rich.
Hey, just a couple follow-ups. Can you just give us a sense, though, on the commercial meter side, the year-over-year, was it down, say, 15%? Or just give us order of magnitude. I know you had a monster comparison in the fourth quarter of 2013. The business was up almost 30%.
Can you just give us a general sense of how much down year-over-year that was?
Actually, for year-over-year, commercial was up.
We were up about 4% year-over-year, but for the quarter, we were down about 9%.
Okay. Wait, what does that mean? You're saying sequentially you were down 9%?
No, no. From Q4 of 2013 to Q4 of 2014, commercial sales were down about 9%.
Oh, okay. That's the number I was after. All right.
For the full year, we were up about four.
Okay. I got you. Okay. The industrial flow business, I know we've got some oil and gas, some petrochem. You mentioned some fracking exposure there. Obviously the U.S. economy is perking up and it's on upward trend. That business tends to lag, industrial spend. Is there any reason why you would not budget or plan for that industrial flow business to be up mid-single digits or something in 2015? It certainly has a better backdrop.
No, you're right, Rick. That is our plan. The other thing we did, as I mentioned before, is effective October 1st, we did some restructuring of our reporting within Badger Meter and put the flow instrumentation group basically under one VP and into a separate group so we could achieve some greater focus. We think that's also going to help us.
For the record, that decision was in the works prior to Rick Eastman suggesting it to us several times.
Yeah. Right.
Okay. Well, I'm certainly glad that we did that.
I think you spoke to me at last year's annual meeting and said, "Why don't you do something like that?" We don't want to give you credit for the idea.
That's fine. You know what? That's just great. I wouldn't expect you guys to. Hey, just last thought. Rich, we bumped into a couple situations where Badger Meter's AMR products have been displacing FIREFLY, which is Datamatic, which is now Zenner, I believe.
Right.
Just recently in December earlier in the year, have you guys maybe targeted those installations? Because obviously the technology is proving to be defective. Have you targeted these FIREFLY installations? If so, can you just give us a sense of maybe what that install base is and if there's an opportunity there?
Yeah. There's no question we have. As soon as Datamatic filed bankruptcy, refused to support the warranty on the FIREFLY units, we had a list of the customers. Our field salespeople went out, sat down, talked to the customers about what we could do to help them transition over to Badger. Rick, this just continues to amaze me because years ago, there was a company in the U.S. called Raymar that had a product out there that failed, Raymar immediately filed bankruptcy. Then for about five or six years after that, all of the water utilities were very careful about the companies they bought from to make sure that they were a company that financially could support future warranties. Like everything else in the business world, people have short memories.
Then along came Datamatic with a very weak balance sheet, and sure enough, some utilities decided to gamble on it again. This is the second time they've been burned with this, and I'm truly hoping that the utilities will go back to realizing that the balance sheet of the company standing behind the product is actually a very important aspect of the buying decision. In the case of FIREFLY, yeah, we're out there trying to convince those customers that even though they were buying a very cheap product, a very cheap solution, and ours is more expensive, there's a reason why ours is more expensive, and they should really consider it.
Okay. Great.
Apologize for making the commercial. I felt I had to.
No, that's all right. I walked you into that one. All right. You wouldn't want to offer kind of a target number in terms of revenue or something that you guys are pursuing?
It's a little hard to do that at this point.
Yeah.
It really is. Part of the problem is.
They weren't a major player either, though.
Yeah. Datamatic was never a big player. FIREFLY never had a big part of the market. Part of the problem is, there's a little sticker shock when these utilities chose to buy the cheapest product on the market, and we come in and say, "Well, that failed. Here's one that won't fail." They see the price, they're a little shocked.
Yeah.
It does take some superior salesmanship to convince them of that.
That is the technology that Zenner now owns, right?
Yes. Well, and I'm looking at Cindy, our Director of Sales, who's sitting here. Zenner bought that FIREFLY technology, Cindy?
Yeah.
Yeah.
Okay.
Now there's also a company, Datamatic, Ltd., is what filed bankruptcy. We also understand there's a Datamatic, Inc. out there that is doing something else with the technology. There's still a lot of confusion.
I see. Okay. Hey, great. Thanks again.
Okay. Take care.
There are no additional questions at this time. I would now like to turn the presentation over to Mr. Rich Meeusen for final remarks.
Great. Well, thank you. I want to thank everybody for joining us today. As I said, we were very pleased with 2014 for the year. The fourth quarter had some unusual items in there showing our lumpiness again. As we look into 2015, even with the question about the first quarter weather and groundhogs and everything else that we talked about, as we look at 2015, we're pretty confident that we could have a good 2015 with the products we've got and the market position we're in. Also, the tailwind of copper that I spoke about could be very significant, depending upon where copper prices remain going through 2015. With that, I'll thank you for joining us and look forward to talk to you soon.
Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect.